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Macroeconomics Issues and
Measurement
Chapter 15
LIPSEY & CHRYSTAL
ECONOMICS 12e
Learning Outcomes
• Macroeconomics looks at the economy as a whole,
dealing with such aggregate phenomena as growth in total
output and living standards, commonly called ‘economic
growth’, business cycles, inflation, unemployment, and the
balance of payments.
• Macroeconomics focuses on the cycle in activity, whereas
growth theory focuses on determinants of the long-run
trend in output.
Learning Outcomes
• The GDP gap is the difference between actual real GDP
and its potential or trend value.
• The total output of the economy as a whole is the sum of
the value added by each firm or enterprise.
Learning Outcomes
• GDP can be measured as the sum of value added by all
producers, as the sum of income claims generated in
producing goods and services, or as the spending on all
final goods and services produced.
• GDP measures the value of what is produced in this
country, while GNI (or GNP) measures the income
accruing to UK residents, including net income from
overseas.
• GDP is a specific measure of output in the market
economy, and is not a measure of welfare or happiness.
INTRODUCTION - MACROECONOMIC ISSUES AND
MEASUREMENT
What is Macroeconomics
• Macroeconomics is about the economy as a whole. It
studies aggregate phenomena, such as business cycles,
living standards, inflation, unemployment, and the
balance of payments. It also asks how governments can
use their monetary and fiscal policy instruments to help
stabilize the economy.
INTRODUCTION - MACROECONOMIC ISSUES AND
MEASUREMENT
Why do We Need Macroeconomics
• Macroeconomics is useful because it enables us to study
events that affect the economy as a whole without
getting into too much detail about specific products and
sectors.
INTRODUCTION - MACROECONOMIC ISSUES AND
MEASUREMENT
The GDP gap
• Potential GDP is the level of national output that would be
produced if the economy were operating at its normal
capacity, of full-employment level.
• The GDP gap is the difference between actual GDP and
its potential level.
INTRODUCTION - MACROECONOMIC ISSUES AND
MEASUREMENT
Measurement of National Output
• Each firm’s contribution to total output is equal to its value
added, which is the gross value of the firm’s output minus
the value of all intermediate goods and services - that is,
the outputs of other firms - that it uses.
• Goods that count as part of the economy’s output are
called final goods; all others are called intermediate
goods. The sum of all the values added produced in an
economy is called gross value added at basic prices.
Basic prices are the prices received by producers net of
taxes on products [plus subsidies].
INTRODUCTION - MACROECONOMIC ISSUES AND
MEASUREMENT
Measurement of National Output
• Goods that count as part of the economy’s output are
called final goods; all others are called intermediate
goods. The sum of all the values added produced in an
economy is called gross value added at basic prices.
Basic prices are the prices received by producers net of
taxes on products [plus subsidies].
INTRODUCTION - MACROECONOMIC ISSUES AND
MEASUREMENT
The circular flow of income, output and spending
• The determination of GDP and national income
can be represented as a circular flow of income
and spending.
INTRODUCTION - MACROECONOMIC ISSUES AND
MEASUREMENT
The circular flow of income, output, and spending
• Withdrawals of spending arise when income
received is not spent on the domestic economy.
• Injections of spending are those that are not the
result of domestic income receipts, but rather
come from sources other than domestic income
recipients.
The Circular Flow of Income, Output, and Expenditure
Domestic
households
Financial
System
Abroad
Government
Domestic
producers
The Circular Flow of Income, Output, and Expenditure
• Individuals provide labour to firms and they buy the
firms’ output.
• National output or income can be measured from the
expenditure side in terms of expenditure on the final
output, or on the income side in terms of value added
and factor incomes generated.
• Saving, taxes and imports represent a leakage from
the circular flow.
The Circular Flow of Income, Output, and Expenditure
• Investment, government consumption and exports
represent injections into the circular flow.
• For any equilibrium level of national activity (GDP)
injections must equal leakages.
• So saving plus taxes plus imports must equal
investment plus government consumption plus
exports.
INTRODUCTION - MACROECONOMIC ISSUES AND
MEASUREMENT
GDP, GNI, and GNP
• Gross domestic product, [GDP] can be calculated in three
different ways:
– [1] as the sum of all values added by all producers of both
intermediate and final goods
– [2] as the income claims generated by the total production of
goods and services; and
– [3] as the expenditure needed to purchase all final goods and
services produced during the period.
INTRODUCTION - MACROECONOMIC ISSUES AND
MEASUREMENT
GDP, GNI, and GNP
• By standard accounting conventions these three
aggregations define the same total, so long as we add
taxes on products [minus subsidies] to the first two in
order to measure GDP at market prices.
• Market prices are the prices paid by consumers.
INTRODUCTION - MACROECONOMIC ISSUES AND
MEASUREMENT
• From the expenditure side of the national accounts GDP
= Ca + Ia + Ga + [Xa - Ima].
• Ca comprises private consumption expenditures.
• Ia is investment in fixed capital [including residential
construction], inventories, and valuables.
• Gross investment can be split into replacement
investment [necessary to keep the stock of capital intact]
and net investment [net additions to the stock of capital].
• Ga is government consumption. [Xa -IMa] represents net
exports, or exports minus imports; it will be negative if
imports exceed exports.
INTRODUCTION - MACROECONOMIC ISSUES AND
MEASUREMENT
• GDP income-based adds up all factor rewards in
production.
• The main income categories making up GDP are
operating surpluses, mixed incomes, and compensation
of employees.
• UK GDP measures production that is located in the
United kingdom, and UK gross national income [GNI]
measures income accruing to UK residents.
• The difference is due to net income from overseas.
• GNI is the same thing as what used to be called gross
national product [GNP].
INTRODUCTION - MACROECONOMIC ISSUES AND
MEASUREMENT
• Real GDP is calculated to reflect changes in real
volumes of output and real income.
• Nominal GDP reflects changes in both prices and
quantities.
• Any change in nominal GDP [or GNI] can be split into a
change in real GDP and a change due to prices.
INTRODUCTION - MACROECONOMIC ISSUES AND
MEASUREMENT
• Appropriate comparisons of nominal and real measures
yield implicit deflators.
• Personal income is income received by individuals
before any allowance for personal taxes.
• Personal disposable income is the amount actually
available for individuals to spend or to save, that is,
income minus taxes.
INTRODUCTION - MACROECONOMIC ISSUES AND
MEASUREMENT
Interpreting National Income and Output
• GDP and related measures of national income and
output must be interpreted with their limitations in mind.
• GDP excludes production that takes place in the
underground economy or that does not pass through
markets.
INTRODUCTION - MACROECONOMIC ISSUES AND
MEASUREMENT
Interpreting National Income and Output
• Moreover, GDP does not measure everything that
contributes to human welfare.
• GDP is one of the best measures available of the total
economic activity within a country.
• It is particularly valuable when changes in GDP are used
to indicate how economic activity has changed over time.
UK potential GDP and the output gap, 1970-2014
UK potential GDP and the output gap, 1970-2014
Value added through stages of production
Gross Value Added at Current Basic Prices, by Sector, UK 2008
Expenditure-based GDP and Its Components, UK, 2008
Income-based GDP and Its Components, UK, 2008
UK national income and output measures, 2008
Nominal and real GDP at market prices (1900-2008)
International comparisons of living standards
Revision to UK current balance of payment deficit
(1997 to 2005)